Money Illusion and Coordination Failure

Ernst Fehr and Jean-Robert Tyran

No 177, IEW - Working Papers from Institute for Empirical Research in Economics - University of Zurich

Abstract: Economists long considered money illusion to be largely irrelevant. Here we show, however, that money illusion has powerful effects on equilibrium selection. If we represent payoffs in nominal terms, choices converge to the Pareto inefficient equilibrium; however, if we lift the veil of money by representing payoffs in real terms, the Pareto efficient equilibrium is selected. We also show that strategic uncertainty about the other players� behavior is key for the equilibrium selection effects of money illusion: even though money illusion vanishes over time if subjects are given learning opportunities in the context of an individual optimization problem, powerful and persistent effects of money illusion are found when strategic uncertainty prevails.

Keywords: money illusion; coordination failure; equilibrium selection; multiple equilibria; coordination games (search for similar items in EconPapers)
JEL-codes: C9 E32 E52 (search for similar items in EconPapers)
New Economics Papers: this item is included in nep-cbe and nep-mac
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Citations: View citations in EconPapers (45)

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Related works:
Journal Article: Money illusion and coordination failure (2007)
Working Paper: Money Illusion and Coordination Failure (2004)
Working Paper: Money Illusion and Coordination Failure (2004)
Working Paper: Money Illusion and Coordination Failure (2004)
Working Paper: Money illusion and coordination failure (2004)
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